After federal ruling, California on verge of creating state-run IRA

A bill by state Senate President Pro Tem Kevin de León, D-Los Angeles, would require employ ers to offer their own retirement plan or automatically enroll workers in the state-run plan.

Photo: Mark J. Terrill, Associated Press

The U.S. Department of Labor adopted a landmark rule Thursday that will let states set up retirement accounts for private-sector workers who don’t have access to employer-sponsored plans, such as a 401(k).

The move could have a resounding impact on California, where the Legislature is on the verge of passing a bill that would create this type of state-run plan. The Assembly passed the bill 52-26 Thursday. It previously passed the Senate but must go back to the Senate for final approval.

California is the largest of eight states that are working to create such plans, so the legislation has been closely watched — and criticized by some, who fear taxpayers could be on the hook if returns or participation fall short of expectations, something proponents say will not happen.

The Labor Department rule will let states set up individual retirement accounts for private-sector workers and automatically enroll them, unless the worker opts out.

Nationally, about 55 million people, almost half the private-sector workforce, lack access to a workplace plan, according to AARP. About 7.5 million Californians do not have access to a retirement plan at work, according to an estimate from the the California Treasurer’s Office.

Under the new federal guidelines, states would have to design and run their programs; employers could have only “limited” involvement and could not put any money into worker accounts. The plan would automatically deduct contributions from the employee’s paycheck.

The state-run plans would be exempt from the Employee Retirement Income Security Act if they meet certain requirements. This federal law, known as ERISA, protects participants in private-sector retirement plans, but it puts so many obligations on employers that many small ones do not offer one.

Under current law, workers can open an IRA on their own and fund it through payroll deductions, and the employer will not have to comply with ERISA. But if the employer sponsors the program or automatically enrolls employees, ERISA would probably apply, says Sarah Gill, a senior legislative representative with AARP.

Under the new rule, states can automatically enroll employees in a state-run IRA, and neither the state nor the employer will have to comply with ERISA if certain conditions are met: Employers who don’t offer another plan must automatically enroll workers in the state plan unless the worker opts out. The state must design the program and choose investment options, but could outsource administration to a third party. Employers could have only limited involvement in the plan and could not put any money into worker accounts.

States could set a default investment rate for workers who don’t choose one themselves, and they could automatically raise an employee’s investment rate each year unless the worker objects.

In a notable change from an earlier proposal, the final rule says states can impose restrictions on withdrawals that do not apply to IRAs, such as preventing withdrawals or transfers to another IRA before a certain age or within a certain number of years. The earlier proposal would have banned states from imposing such restrictions, “to make sure that employees would have meaningful control” over their assets. In the end, the Labor Department said such decisions “are better left to the states.”

The Investment Company Institute, which represents mutual funds, objected to that change because it could lock employees into plans that are not delivering as promised or no longer fit their needs. “We hoped employees would have the right to move out at any time they wanted, like any other IRA owner,” said Elena Chism, the institute’s associate general counsel.

The institute’s “overriding concern” is that the rule creates a two-tier system, said Brian Reid, its chief economist. Employers who set up their own plan will be subject to ERISA, whereas those who opt for the state plan will not. “The incentive at the margin is to say (the state-run IRA) is a much less costly approach.”

The group also worries about the patchwork of plans that could spring up in different states and, potentially, cities. In a surprise move, the Labor Department also proposed a rule Thursday that would let cities and counties that have more people than the least populous state (Wyoming) set up auto-enrollment IRAs exempt from ERISA unless their state offers such a plan.

In California, SB1234, by state Senate President Pro Tem Kevin de León, D-Los Angeles, would require employers to offer their own retirement plan or automatically enroll workers in the state-run plan, called Secure Choice, the creation of which was contingent on the Labor Department’s ruling. Employees would have to acknowledge having received a disclosure packet and could opt out at any time. It applies to any company that has five or more workers in the state, no matter where they are headquartered.

The investment rate for each employee would start at 3 percent of pay and could go up 1 percent each year until it hits 8 percent.

For the first three years of the program, employees could invest only in U.S. Treasury securities or a myRA, which is a new type of Roth IRA for beginning savers that also invests only in government debt. One-year Treasurys are yielding 0.5 percent, and the 10-year yield is 1.5 percent. The fees charged to investors would be capped at 1 percent, which is higher than most workplace plans.

Of the estimated 7.5 million Californians who do not have access to a retirement plan, two-thirds work for companies with fewer than 100 employees, and two-thirds are people of color, according to the state Treasurer’s Office.

“We think up to 6 million people could participate” in Secure Choice, said Blanca Castro, director of advocacy for AARP’s California office. “This is not going to be a solution for the retirement savings deficit across the board. But you have to start somewhere.”

Kathleen Pender writes the Net Worth column in The San Francisco Chronicle. She explains how the big business and economic news of the day affect a household's net worth. She covers saving, investing, debt, taxes, housing, mortgages, retirement plans, employment and unemployment with a focus on issues specific to California and the Bay Area.

When it comes to big financial decisions, she believes that the simplest answer is almost always the best and that people would stay out of money trouble if they didn't get involved in things they can't understand. Pender welcomes questions from readers and frequently answers them in her column.

She majored in business journalism at the University of Missouri-Columbia and was a Knight-Bagehot fellow in business journalism at Columbia University.